Should I do designated Roth contributions (i.e., a Roth 403(b))?

[RamS]

I contribute very close the maximum possible for retirement each year ($57K in 2020).  It is all pre-tax, and I was ineligible for a Roth IRA due to income limits so I never thought about after-tax contributions which I starting to do now. (Also looking for ways to save more than the $57K, see PS below.)

Somewhat recently, when I change my voluntary employee contribution (not the part that is matched which is considered non-voluntary, but the part on top of it), my system would ask me do you want to split it between pre-tax and after-tax. I continued making it pre-tax since I thought the income limits would apply.  However, this would be a Roth 403(b), not a Roth IRA.  I've been reading this about designated Roth contributions (https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts) and it seems to not have income limits (which I thought it did). So I could designate a portion of my 19,500 voluntary contribution I contribute each year to a Roth account.

Is this something I should do? I've considered things like a backdoor Roth conversion, etc. but now it would cost me a lot and it doesn't make sense since I'm still in a growth phase. But perhaps at some point it would be unavoidable (to do the backdoor conversion).  So if I had a Roth account going, this would lessen the pain (let alone enabling me to do it in the first place). Plus there are benefits in terms of leaving stuff to our kids - we could leave the Roth money but spend off all the IRA or vice versa?  I should be able to build on the Roth account for another 20-30 years perhaps going up as high as 19,500 per year.

The way I've seen sites answer this is to ask a question about one's tax situation later on. I guess my answer is I don't know. It could be lower or higher - I hope to never stop working but that depends on things like health, mood, etc. and also tax rates by the government may go up or down. Another answer is that it is good for tax diversification purposes so perhaps I should do it just to have the option.

The  but I could also split it.

The question is should I start contributing to a Roth 403(b) and should I contribute the maximum for the year 2021 ($19,500) or should I split it (the effect on my paycheck should be minimal---at an effective tax rate of 0.3%, it is $225/paycheck for 19,500 contribution in 2021)? Since I have the pre-tax 403(b) I'd like to see it grow also so perhaps I should split into half, but then again, the remaining $37K is going into another pre-tax account. 

Happy Holidays/Christmas/New Year!

--Ram

PS: A 457(b) plan won't let me save more over the $57K limit right? The only thing I've seen that can do that (short of turning age 50) is that I can contribute $6000 for my wife (who doesn't work) in an after-tax traditional IRA (here presumably the Roth IRA married filing jointly income limits would apply).

[ericrugiero]

If you are planning for early retirement it makes sense to contribute most or all of your money in pre-tax because after retirement you can roll it all to a traditional IRA and then gradually convert it to a Roth IRA (paying taxes at the lower income level). 

The danger is that if you keep working too long, you will run into RMD's which require you to take a certain % out based on age and that can be a large amount which is taxed at a higher rate.  With the large contributions you are making to pre-tax accounts and what you said "I hope to never stop working", this could be a likely problem for you.  In your shoes, I would do some kind of split between pre-tax and Roth.  If you were planning to retire early, I would do more pre-tax and convert to Roth after retirement. 

My personal plan is to contribute mostly traditional 401K but convert it after retirement and have mostly Roth IRA money left when I pass away because of the tax advantages for my kids.  But, if you "never stop working" you may have limited years with low income to do those conversions. 

[PhrugalPhan]

Without knowing your future plans (how long you will work, where you will live, how much you will earn, what tax rates will be, do you want to consider an inheritance, so on...) that is a hard question to answer.  If you're considering Roth but don't know, I would recommend contributing a small percentage to start and keep going over it in your mind and change it as you go forward.  As pointed out above, even with high taxes now it "could" make sense to do some Roth at this time.  If you are not retiring early (as I am not really) and have a pension (as I have) having more in Roth really helps.  I am maxing out Roth right now even with some at 24% Fed. taxes which for most people is crazy, yet makes sense financially for me.

[Holocene]

I'm surprised you're able to put $57k in all pre-tax.  Usually people reach this amount by making after-tax contributions above the regular $19.5k (ie. mega backdoor Roth, different than regular Roth contributions).  Is your employer putting in that extra $37.5k pre-tax?  Because that's a pretty sweet deal if so.  Or maybe you're self-employed?

In any case, it really depends on a lot of factors.  What is your current income/tax bracket?  How much do you have in pre-tax, Roth, and taxable accounts currently?  How long do you plan to work?  Do you expect your income to increase and push you up to a higher tax bracket?  Do you plan to quit working fairly young or go part-time or to a lower paying job?  Do you expect a large windfall at any point?

In general, especially for people striving for FIRE, I think traditional pre-tax contributions make the most sense.  But this is a generalization, assuming you have a high income now putting you in a high tax bracket and that you plan to retire early and have plenty of years to convert to Roth at a lower rate.  Keep in mind as you're withdrawing the money, the first $12k is tax free, the next $10k is at 10%, the next $30k is at 12%, etc.  Double that if you're married.  So while you defer $57k now at your higher tax bracket in the accumulation phase, the money will be withdrawn at lower brackets until they are filled up.  Obviously tax laws change and anything can happen.  If you're planning to max out $57k every year until you retire at 72 and start taking RMDs, then yeah, it'd probably make sense to start diversifying into Roth now since you'll have a shit-ton of pre-tax money that will have very large RMDs pushing you up in tax brackets.  But if you're planning to retire before 50 and have 20+ years to convert the money, it probably makes sense to keep it all pre-tax.

For most people, I advocate allocating as much to pre-tax as is allowed.  But since you mentioned wanting to keep working and $57k is a lot to go into pre-tax, it may make sense to start allocating some to Roth.

Do you have money in an existing traditional IRA?  If you do, can you roll it into your 403b?  If you can roll it in or if you don't have a traditional IRA, then you can do a backdoor Roth IRA now.  This means just contributing to a non-deductible IRA and immediately converting it to a Roth IRA.  If you have a large amount in a traditional IRA that you can't roll over, then I agree this doesn't make sense.  You don't want to be converting traditional money to Roth now while in a high tax bracket.  But that's also why it probably doesn't make sense to do a Roth 403b now either.

[MDM]

The way I've seen sites answer this is to ask a question about one's tax situation later on. I guess my answer is I don't know. It could be lower or higher - I hope to never stop working but that depends on things like health, mood, etc. and also tax rates by the government may go up or down.

You may have already seen this part of Traditional versus Roth - Bogleheads:

If one does not believe a reasonable estimate is possible (see Estimating future marginal tax rate for suggestions), consider
* Using 100% traditional because, for most people, traditional will be better
* Using 50% traditional and 50% Roth because then you can't be more than 50% wrong.

Tax brackets and rates may move, but perhaps not so wildly that it would make a huge difference to your choice.

The things under your control that may have a significant effect are at least under your control....

[RamS]

Thank you all for the responses.

ericrugiero: I think the idea of doing half and half or just easing in slowly makes the most sense and I could wait as I do until it is time for my income to cross the SS deduction limit to double my employee side of my contributions which occurs around June/July given my income (not that we live that way but I've now changed my paycheck contribution four times in the last four pay periods and if there's a human operator behind it, they're going to be wondering what's happening*).  Thank you for the suggestion!

We make ~$300K+/year with a tax bracket of MFJ of 24% I think but I believe our effective tax rate last year was 27%.

PhrugalPhan: As I mentioned, I hope to work as long as I live/can. My wife is technically retired but is a serial entrepreneur and is always looking to do something to keep herself busy which generates some income sometimes. We both have smaller sources of income outside of the traditional salary (consulting, investments, etc.), included in the figure above. Yes to the inheritance (50% for charity, 50% for our offspring). The other two answers are below. As to where, currently NY. We're thinking of buying some property south (FL to TX) and we have a home outside the US (Thailand mostly, which is where I'd like to be at the end).

Vapour: Yeah, it is a good deal but an additional 6% is taken out of my salary and my employer matches 8% on top of the $19,500 voluntary contribution which is not matched. This 14% is considered "mandatory" contributions and is listed as a 414(h) pickup so it doesn't get counted as a voluntary employee contribution which is another 7% or so.  I will reach 50 in a couple of years and plan to contribute the 6K or so more since right now I couldn't even contribute the full $19,500 before hitting the 57K limit*. The bottom line is that I contribute as much as possible of the $19,500 on top of what gets "picked up" by my employer to reach 57K.  (I wonder even if I can contribute more via the 457 mechanism but I'm not sure, I think the $57K is the hard limit so far at least according to my accountant except for the $6000 I can contribute on behalf of my wife.)

And yes, I have a large Rollover IRA that can invest in a huge diversity of funds and that is about half my retirement portfolio. The other half is in the the 403(b) and the 414(h) pickup accounts which are separate. So three retirement accounts total, all at Fidelity.  I was given the option to rollover what is in my IRA into the 403(b) when I switched employers but it didn't make sense since my new employer provides only a limited set of choices for investment whereas I wanted to keep the option open to a full fledged brokerage and it helps with fund diversification at least. Not sure if I still can do it but again, aside from limiting my investment choices, what difference would it make? It would still be a tax deferred and if I wanted to put it into the Roth portion, my tax bracket is high enough it'd be a big chunk of that. It seems contributing to the Roth 403(b) and then slowly rolling over portions as I get older may be the way

MDM: If I keep working, I expect my salary will keep rising. The only reason I can see myself stopping is for something I don't see right now. If it happens, then our income will be low and of course it makes sense to do the conversion then. But there's a risk it never happens UNLESS I die first in which case does my wife would likely be in the lowest bracket.  I guess that's a way to look at it: likely as long as I'm alive, it'll be a higher income bracket at age 70 but unlikely otherwise (not certain either way---my wife has had some periods where she once made more than me before but she doesn't seem to want to work like that again).   

If I could plan it out, i.e., I knew ahead of time when I was going to die, I could retire a year or two before my death and then get my income to the lowest bracket and then do the conversion. So at some advanced age, I could just do it or even take a leave of absence, we'll see.

--Ram

* this is a complicated story as to why but when you are trying to get as close to the the $57K limit as possible,  and the contributions don't show up right away all of a sudden (never happened before) -- apparently they have the month it is deducted from my paycheck + 15 business days to do it  - perhaps whoever they saw me coming close and ended up with manual checking so I don't go over but it seems to have gone in last night just fine on time (the previous three times it was delayed by as much as a month but varying wildy and varying between employee and employer contributions - weird).

[fuzzy math]

The 457b is separate. I contribute $57k to my 403b and another 19.5k to my 457b. I'm assuming you're govt  education? Govt 457b are the best.

With your income and your tax rate and the fact that you will leave NY, I would not recommend contributing to a roth. It seems your expenses will go down and you'll likely be taxed less in retirement. You'd be paying taxes now on your highest income rates.

[Holocene]

And yes, I have a large Rollover IRA that can invest in a huge diversity of funds and that is about half my retirement portfolio. The other half is in the the 403(b) and the 414(h) pickup accounts which are separate. So three retirement accounts total, all at Fidelity.  I was given the option to rollover what is in my IRA into the 403(b) when I switched employers but it didn't make sense since my new employer provides only a limited set of choices for investment whereas I wanted to keep the option open to a full fledged brokerage and it helps with fund diversification at least. Not sure if I still can do it but again, aside from limiting my investment choices, what difference would it make? It would still be a tax deferred and if I wanted to put it into the Roth portion, my tax bracket is high enough it'd be a big chunk of that. It seems contributing to the Roth 403(b) and then slowly rolling over portions as I get older may be the way

The reason I mentioned potentially rolling your existing IRA into the 403(b) is because this would allow you to contribute to a Backdoor Roth IRA.  I was not implying that you should convert your traditional rollover IRA money to Roth.  But if you don't have any money in a traditional IRA, this would allow you and your wife you contribute another $12-13k into tax advantaged accounts by funding a non-deductible IRA and then immediately converting it to Roth.  You pay tax on the gains, but if you do it immediately, the tax should be $0 or close to it.  Check out the Bogleheads Backdoor Roth IRA Wiki: https://www.bogleheads.org/wiki/Backdoor_Roth

From that article, here is why you have to be careful about existing Traditional IRAs:

If you have any other Traditional IRAs, the taxable portion of any conversion you make is prorated over all your Traditional IRAs; you cannot convert just the nondeductible amount. There are three options for how to deal with a Traditional IRA getting in the way of a Backdoor Roth IRA:

1) Convert the entire Traditional IRA to Roth, and pay tax on the pre-tax amount of the conversion. For a small Traditional IRA this may be the easiest and best option, but if the Traditional IRA is large, this will result in a large tax bill. If you are making Backdoor Roth IRA contributions, you are in a middle or high tax bracket, so this might be undesirable.

2) Roll the pre-tax portion of the Traditional IRA into your 401(k) or 403(b) at work, assuming it accepts rollovers. If the employer plan has poor investment options and/or high fees, this may be undesirable. However, if the employer plan is large and well-managed, it may have access to institutional share classes with even lower expenses than are available in the IRA.

3) Start a business, open an Individual 401(k) that accepts rollovers, and roll over the Traditional IRA into the Individual 401(k). The amount of the rollover is not limited by the amount earned by the business. For example, a $10M Traditional IRA can be rolled into an Individual 401(k) opened on $10 of legitimately-earned self employment income.

It sounds like #2 could be an option for you.  But you'll have to consider how large your current IRA balance is and whether or not it's worth limiting your investment choices.  Since you're already investing $57k a year into the 403(b), I'm hoping the choices aren't too bad.  The main thing I'd be concerned about is fees.  As long as you have some index funds with fees less than 0.5%, it seems like it'd probably be worth it to be able to add another $12-13k to an account that will never be taxed again.  That's also assuming you want to save that extra amount, since you are already saving a lot.  And you mentioned 457b, so maybe it's possible you can just save into that instead and not deal with the backdoor Roth.

With the additional details you provided, I'd say go ahead and do whatever makes you feel most comfortable.  24% isn't that high of a rate to pay taxes on now, but that's only considering the federal taxes.  If you have high state/local taxes and plan to move eventually, that's something to consider as well.  If it were me, I'd do all pre-tax and retire ASAP.  But it sounds like you want to work forever and definitely past the point of being FI.  In which case, it probably doesn't really matter.  You'll have way too much money that you'll never use it all.  Who cares if it's taxed higher if you don't need it anyway?  And if you for some reason can't or don't want to work anymore, you're more likely to have "enough" if it's in pre-tax than if it's Roth.

But, your heirs may appreciate more in a Roth account.  The stretch IRA was pretty recently killed by the Secure Act, so now you have to withdraw from an inherited IRA in 10 years instead of RMDs based on the age of the heirs.  So if your entire portfolio is pre-tax right now, it might make sense to start diversifying into Roth for the sake of your heirs.